As the year starts in earnest it’s a good idea, but a slightly dangerous one given it could bite me on the arse, to reflect on assumptions made about the market growth last year and see what the market is likely to hold this year.
Last January we put out the document Services In 2017 At 2.9% Growth, But Likely To Be Revised Down As Politics Trumps Economics. Our view at that time was that the market would pretty much carry on in its torpid state for the year, with the drag from traditional services continuing to hamper any meaningful growth in new areas, keeping the overall services business slow. Even this cautious prediction is likely to be impacted downward by macroeconomic impact from geopolitical events like Brexit and the unknowns from the Trump presidency.
This seemed like a reasonable approach, given the general doom and gloom accompanying many commentators analyzing the impact of these events and the lack of any historic precedents. However, it still appears that we have a way to go before these trends impacts spending on IT and business services as a macro driver. It may be that the impact on the services market is hidden by a sudden uptake of services—spurred, for example, by the need for cautious business leaders to invest after the ‘wait and see’ period preceding the Brexit vote—but this seems doubtful. In a market that has weathered uncertainty after uncertainty, buyers have just gotten on with it. Caution is already embedded into the contracting process; current savvy buyers make sure that new services procured deliver value regardless of other external happenings that can’t be influenced, with the specter of market oblivion much more likely to come from a lack of action in the current tide of disruption than from a macroeconomic event.
So, as we said last year, the big transition in the market and what will dictate growth in the next few years is the adoption of new style services engagements—newer models of engagement away from traditional people- and cost-based approaches and toward those more focused on consumption and outcome. Market growth overall has been slowed in the past by the transition from these higher-priced, lower (business) value services toward lower-priced, higher (business) value offerings, where pricing and incentives better match outcomes to be achieved.
Our quarterly analysis of service provider revenues shows that growth in the market has started to accelerate with the second half of 2017 looking much more positive. We expect more confirmation of this as we start to see full year results over the coming quarter. Exhibit 1 shows this upward trend.
Exhibit 1: Services Hit the Tipping Point in 2017
Source: HfS Research, 2018
This chart shows how average growth rates have tumbled since their most recent peak in 2011, which was driven by the post-recession recovery and a growing ubiquity of outsourcing and need for IT and business modernization—leading to sharp increases in professional service spend.
However, since that time, we’ve seen growth rates stabilise and then drop across the board. It’s interesting to note the difference between the weighted average and the average, which tells us the real story about growth in the largest of the providers. This indicates that the providers that make up the bulk of the market are the ones that have suffered the most, generally speaking. The average is being dragged up by smaller firms those that have less weight, (although in this case, pretty large and established smaller firms) are driving growth.
As we have commented before, this long decline is a structural change in the market, the result of the services business moving away from old style contracting in managed services and outsourcing and toward more As-a-Service style contracts, and away from older technologies in professional services and toward what we are calling Services for the Digital OneOffice. If anyone is expecting a smooth transition as the new replaces the old: This is the wake-up call, right here. It’s taking a long time for the market to transition from the old to the new; we still see the traditional services firms struggle to balance winning and investing in new areas whilst managing legacy.
However, the third quarter of 2017 showed real signs of improvement in the services business. It is consistent with the upward trend over the past eight quarters, with the exception of Q4 2016 when the market dipped due to a number of concerns around Brexit and Trump. We saw a significant number of digital deals and it seems we may have hit an inflection point where “new style” engagements are driving more growth than the legacy is sucking out of the market.
We are translating this optimism into our market forecasting and are starting by making the first adjustment to the IT Services forecast, which you can see in the 2018 market primer infographic in Exhibit 2.
IT Services Market 2018 Primer
Exhibit 2: The High-Value IT Services Market Primer
Source: HfS Research, 2018
The market primer provides our latest size and forecast for the high value IT Services market, which excludes support services and training and education services. Its main constituents are applications development and management, IT infrastructure management services, and professional services. We have provided a split between the new style of IT Services—what we are calling Digital OneOffice IT Services—and traditional IT Services. Digital OneOffice IT Services are a combination of newer engagement models and services directed at the implementation and running of the new technology change agents.
Although we do expect the old and new worlds to continue for some time, the distinction between the two will become less distinct and less important—particularly as the market overall starts to grow faster. We have increased our forecast for IT Services overall to 4.5%, with OneOffice services growing at 20.7% and the traditional markets declining at 5.3%. We expect 90% of professional services growth to come from the new change agents as consulting and implementation services around traditional IT shrinks.
We can see IT outsourcing being impacted by big price dips in traditional infrastructure and apps work—and general cost impetus—and a falling out of love with outsourcing as a deliverer of value. There is still too much focus on legacy deals, even with the shift toward asset-light, As-a-Service, and cloud taking value out of larger contracts—and the upside of new technologies not compensating. However, we can see some of this changing as growth in cloud services becomes enough to offset these declines.
The application development and management market is still growing faster than the market as a whole. Due to new methodologies like DevOps and the increased “cloudification” of business infrastructure, the lines between IT Services towers continue to fade. This means applications get drawn more front and center and the infrastructure that supports them becomes less important. We have seen more deals and more RFIs where applications and the infrastructure supporting the apps is combined.
Crucially, traditional application management is now largely commoditized with new growth areas stemming from systems integration, application engineering, and design, enabling the adoption of new IT and digital technologies. Indeed, SaaS adoption is set to grow almost five times faster than traditional software product delivery, with many large businesses showing a preference for the As-a-Service model instead of capital investment.
In 2016, the number of contracts for custom application development (CAD) and maintenance accounted for 25% of the total market activity, whereas the application maintenance share reduced to 18%. In 2017, we expect customization to be the second service in demand under ADM, after SaaS services.
The professional services market has been kept buoyant with new technologies and digital. However, the cost of professional services and the way they are priced is increasingly at odds with pricing for operational IT services—with operational services becoming cheaper and more efficient over the past decade through the use of cloud, better development platforms, standardization, automation, and offshore. This disparity between the perceived value of professional services and operational services is starting to show in customer attitude toward consulting, with buyers falling out of love with the contradiction of advice given to them to shift to new business models from the same breed of MBA suits, charging a similar level of day rate to ten years ago.
Bottom Line
We expect to make some additional changes to the market forecast over the next two months as we do a full forecast refresh when the Q4 2017 results are fully analyzed and we get the results from our State of the Industry survey. However, we expect the overall IT Services market is likely to increase in spite of the uncertainty that the world is facing.
The structural changes in the market have taken shape over the past five years and the worst of the drag from the traditional market is past us. This means that we can expect some higher growth rates for service providers going forward, at least for those that have been able to successfully make the transition into the new services world.
Buyers in the market have shown that political uncertainty, although impactful, will not slow down the transition to more digital ways of operating, and thus will not stop the important work IT organizations are undertaking to transform. What is changing, however, is the services customers are seeking: lower risk and shorter project lifecycles where the buyer can get value for money in real time. The tipping point is finally here and we expect Digital OneOffice Services to take the lead from here on.